Tight liquidity conditions combined with specific credit issues (IL&FS) led to a big reset for NBFCs as well as housing finance companies (HFCs).

The stock market carnage in September was largely driven by fall in NBFCs. Tight liquidity conditions combined with specific credit issues (IL&FS) led to a big reset for NBFCs as well as housing finance companies (HFCs).

The lending reluctance toward NBFCs is expected to continue considering the uncertainty in the credibility of rating agencies and credit profile of NBFCs, suggest experts.

Most of the quality NBFCs also witnessed a double-digit decline and are now looking attractive. Experts suggest investors can look at stocks which have credible management and superior asset liability management (ALM) profile.

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“The lending reluctance towards NBFCs is likely to continue and the source of easy money will be limited. Though we expect the switch from capital market borrowings to bank borrowings would be rapid, however, considering overall cap limits over sector-specific exposure, even banks would be pricing the debt accordingly,” Emkay Global said in a report.

“Though we see low probability of default, margin compression is inevitable for most NBFCs in the market. Since the liquidity crunch and its aftermath are expected to stay for a while, we prefer NBFCs with decent promoter backing and superior ALM profiles,” it said.

Funds availability could remain tight over the medium term which could well impact growth as well as margins for NBFC stocks. NBFCs/HFCs most exposed are the ones with (1) high CP (commercial paper) funding and refinancing risk; (2) low-margin businesses like HFCs; (3) wholesale asset financiers.

“Liquidity conditions are unlikely to turn benign in the near term driven by both global factors (crude, currency, flows) and local factors (elections, festive season) and with the IL&FS credit issue, banks and MFs will likely reduce or at best maintain their exposure to NBFC/HFCs,” Nomura said in a report.

“We like MMFS (M&M Financial Services) and SHTF (Shriram Transport Finance) which will be most immune. LICHF/HDFC’s margins will be affected, but valuations in the case of LICHF and subsidiary valuation support in the case of HDFC Limited restrict us from downgrading. The key beneficiaries will be CASA-funded and private corporate banks like ICICI, Axis and HDFC Bank,” it said.

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MMFS has seen an increase in its funding from CPs and mutual funds and might not remain completely immune to the liquidity tightens, but the investment bank is of the view that its diversified funding profile and higher asset limits will limit the impact on its fundamentals.

The asset quality is turning around and in spite of our 5-8 percent earnings cut for FY19-21F, Nomura expects a return on equity (ROE) of 17 percent by FY20F.

With ongoing liquidity pressure, the investment bank has slashed AUM growth estimates from 21 percent to 19-20 percent for FY19-20F and trim their margin expectations by 30bps for FY19-21F, translating to ROEs of 17-18 percent for FY20/21F vs. 18-19 percent earlier.

Nomura maintained a buy rating on Shriram Transport Finance with a target price of Rs 1425. It has a well-diversified funding profile including its large securitisation book.

While it will not remain immune to current liquidity conditions given rising funding from MFs, Nomura believes that its high yielding asset book and improving commercial vehicle (CV) asset quality cycle will limit the impact on its fundamentals.

Nomura maintained a buy rating on HDFC with a target of Rs 2000. HDFC Limited will be better placed in this liquidity tightening situation, in spite of meaningful CP exposure, given its strong credentials and a high proportion of deposit funding.

However, incremental mortgage spreads will remain under pressure, hence, the outlook for HDFC’s mortgage business remains weak, but subsidiaries at current prices (after a 15% holding discount) account for 58 percent of the value.

Nomura maintained a buy rating on LIC Housing Finance with a target price of Rs 500. LICHF is over 80 percent funded by non-bank sources and over the past two years, the share of commercial papers (CPs) and mutual funds (MF) funding in its incremental funding has gone up but: (1) the overall share of CP funding still remains the lowest at ~5-6% of the funding; (2) its strong parentage should aid in the current liquidity conditions.

Nomura believes that the liquidity will be manageable for LIC Housing, but it remains most exposed to the pressure on incremental mortgage spreads. Current valuation at 1.15x Sep-20F book is undemanding, hence Nomura maintains their buy rating.

The brokerage firm believes that its foray into Housing Finance (HFCs) and the ongoing expansion into rural geographies will further reinforce its growth momentum. The stock trades at 5.3x FY20E Adj. BV and 26x FY20E EPS, for a return profile of average 3.5%+ ROAs / 20%+ ROEs.

Emkay Global upgraded the stock to buy from accumulate rating earlier on Cholamandalam Finance with a target price of Rs 1475. CIFC has de-risked its product portfolio, which has insulated it from the CV down cycle.

Among CV financiers, it has the most diversified lending portfolio compared with most of its peers. The company has reported robust sales growth, along with stable asset quality.

Elevated leverage has resulted in a superior RoE, and as a result, the stock trades at a premium to its peers. However, Emkay Global also believes that consistently higher earnings growth and better ROEs do justify its premium valuations.

Emkay Global maintained its buy rating on Edelweiss Financial Services (EDEL), as it believes that the company will continue to pursue aggressive growth in superior RoE businesses, which in turn will result in healthy PAT CAGR of 21 percent over FY18-20E.

The brokerage firm is factoring in consolidated RoE (post-dilution) to improve to 16 percent by FY20E. Although the capital consumption had been relatively steep in the past quarters, management was confident of maintaining growth.

Emkay Global maintained its buy rating on L&T Finance Holding with a target price of Rs 202. L&T Finance Holdings (LTFH) has successfully transformed its lending business to focus on ROEs and sustainable growth.

The consolidated return on equity (ROE) has improved from 10 percent in FY16 to 15 percent in FY18. Being a diversified financial services player, LTFH has multiple growth drivers — about 7 product lines under 3 business verticals in the lending business.

In addition, its robust and sustainable fee income franchise helps in maintaining high profitability. Emkay expects LTFH to record a consolidated PAT CAGR of 38 percent during FY18-20E.

Emkay Global maintained its buy rating on Magma Fincorp with a target price of Rs 176. The professional management brought in by Magma Fincorp (MGMA) is focused on improving asset quality and bring in underwriting discipline.

The structural changes implemented in the recent past have started paying off in the form of declining asset-quality pressures and management’s ability to kick-start growth again.

Further expected improvement in asset quality, the return of growth, and a superior loan portfolio overall at a fairly cheap valuation make MGMA the most attractive stock among its peers.

Emkay Global maintained its buy rating on Shriram City Union Finance with a target of Rs 2156. Shriram City Union Finance (SCUF) has built a niche and diversified business model, focusing on the underserved and under-penetrated MSME segment in the rural and semi-urban areas. AUM in Q1FY19 grew 20.5 percent on a YoY basis.

With the reduction in problems related to the gold loan business and demonetisation, and due to its strong capital position, SCUF remains well positioned for the next phase of growth. ROEs should improve gradually as leverage increases.

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